You are given the following information for Watson Power Co. Assume the company\

Question

You are given the following information for Watson Power Co. Assume the company's tax rate is 35 percent. 9,000 7 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 106 percent of par; the bonds make semiannual payments. 420,000 shares outstanding, selling for $60 per share; the beta is 1.03. 20,000 shares of 4 percent preferred stock outstanding, currently selling for $80 per share. 9 percent market risk premium and 5 percent risk-free rate. What is the company's WACC?

Explanation / Answer

WACC =Wd * Kd + Wp * Kp + We * Ke

Wd = weight of debt

Wp = weight of preferred stock

We = Weight of equity

Weights shall be calculated on the basis of Market Value

Market Value of Debt = 9000 * 1000 * 106% = $9540000

Market Value of Preferred Stock = 20000 * 80 = $1600000

Market Value of Equity = 420000 * 60 = $25200000

Total Market Value = $36340000

Kd = 7% (1-.35) = 4.55%

Kp = 4%

Ke = Risk free rate + Beta * MArket Risk Premium = 5% + 1.03 * 9% = 14.27%

WACC = 4.55% * 954 / 3634 + 4% * 160 / 3634 + 14.27% * 2520 / 3634

= 1.1944689% + .1761145% + 9.895542%

= 11.27%

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